Transcript Chapter 13 Pricing in the Business World

Part 3: The marketing mix
Chapter 13: Setting prices for goods
and services
Step 5: Design the marketing strategy
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When we finish this lecture you should
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Understand how most wholesalers and retailers use mark-ups
Understand why turnover is so important in pricing
Understand the six different types of cost
Understand the advantages and disadvantages of average-cost
pricing
Understand the use of break-even analysis in evaluating
possible prices
Understand the advantages of marginal analysis and how it is
used in price setting
Understand the various factors that influence customer price
sensitivity
Be familiar with the use of demand estimates in pricing
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Strategic pricing
• Strategic pricing decisions are essential if an
organisation is to compete successfully in the
marketplace
• Pricing objectives and policies should guide these
pricing decisions
• The traditional method for companies to set prices
is to add a standard mark-up to the average cost of
the products they sell
• Now managers are realising that they should
evaluate the effect of a price decision on demand
and therefore sales volume, costs and total profit
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Figure 13.1 Key factors that influence price
setting
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Mark-ups
• Mark-up—Dollar amount added to the cost of the
products to get the selling price
• Standard mark-up per cent—The percentage of the
selling price that is added to the cost to get the
selling price—the per cent of selling price unless
otherwise noted
• Products may be marked up several times through
the channel—The sequence of mark-ups is the
mark-up chain
• Margins and profitability—High mark-ups do not
always mean high profits; profitability depends on
the inventory turnover rate
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Inventory turnover rates
Number of times average inventory is sold in a year
1. (Cost of sales) / (Average inventory at cost)
2. (Net sales) / (Average inventory at selling price)
3. (Sales in units) / (Average inventory in units)
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Types of cost
• Total fixed costs (TFC)—Sum of those costs that are
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fixed in total, irrespective of quantity sold
Total variable costs (TVC)—Sum of those variable
expenses that are closely related to output
Total cost (TC)—Sum of total fixed and total variable
costs
Average cost (AC) per unit—Total cost divided by
related quantity
Average fixed cost (FC) per unit—Total fixed cost
divided by the related quantity
Average variable cost (AVC) per unit—Total variable
cost divided by the related quantity
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Average-cost pricing
• Adding a ‘reasonable’ mark-up to the average cost
of a product
• Simplifies pricing
• Quite common, especially among intermediaries
• Average cost is usually based on estimates or past
records
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But actual average costs depend on quantity sold
And quantity sold depends on price
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Figure 13.3 Results of average-cost pricing
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Figure 13.4 Cost structure of an organisation
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Figure 13.5 Typical shape of cost (per unit)
curves when average variable cost is assumed
constant per unit
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Figure 13.6 Evaluation of various prices along an
organisation’s demand curve
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Figure 13.7 Summary of relationships among
quantity, cost and price using cost-oriented
pricing
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Break-even analysis
• Used to evaluate whether the organisation will be
able to cover costs (break even) at a particular
price
• Indicates the break-even point (BEP)—that is sales
(units or dollars) needed to break even
• Can be modified to incorporate a target return
• Limitations of break-even analysis
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Assume any quantity can be sold at a given price
Total cost curve is assumed to be a straight line
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Figure 13.8 Break-even chart for a particular
situation
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Marginal analysis
• Company should produce that output where
marginal cost is just less than or equal to marginal
revenue
• Marginal analysis—Evaluating the change in total
revenue and total cost from selling one more unit—
to find most profitable price and quantity
• Marginal revenue (MR)—The change in total
revenue that results from the sale of one more unit
of a product
• Marginal cost (MC)—Change in total cost that
results from producing one more unit
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Figure 13.9 Revenue, cost and profit at different
prices for an individual organisation
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Figure 13.10 Graphic determination of the price
giving the greatest total profit for a company
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Marginal analysis—Price leadership
• In industries dominated by a few major companies,
a price leader appears and other members of the
industry follow
• Price leader is usually a seller who sets a price to
maximise profits or to achieve a certain target
return on investment
• Price leader usually the company with the lowest
costs
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Demand-oriented approaches
• Value-in-use pricing
• Online auctions
• Customer reference prices
• Leader pricing
• Psychological pricing
• Odd-even pricing
• Prestige pricing
• Price lining
• Demand-backward pricing
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Figure 13.11 Demand curve when psychological
pricing is appropriate
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Figure 13.12 Demand curve showing a prestige
pricing situation
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Full-line pricing
• Full-line pricing involves setting prices for a whole
line of products
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Market-oriented pricing
Company-oriented pricing
Costing the line
Complementary product pricing
Product-bundle pricing
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Tendering and negotiated pricing
• Tendering—Offering a specific price for each
possible job, rather than setting a price that applies
for all customers
• Negotiated price—A price that is arrived at after
bargaining between the buyer and seller
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What we will be doing in the next
chapter
• In the following chapter we will be discussing
marketing communications, including
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Integrated marketing communications
Why marketers use a blend of promotional methods
Why the Internet has changed the communication
process
How marketing communication plans are designed and
who should manage them
What an advertising agency is and how it operates
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